Caterpillar Stock’s Slide Highlights Jitters Over Economy

Caterpillar’s
(ticker: CAT) forecasts for earnings and sales disappointed investors, and the stock fell about 8% in early trading.

Management expects the company to earn about $12.25 per share this year, after what Caterpillar called “a modest increase in sales.” That’s disappointing: Wall Street’s collective guess for 2019 was for earnings of $12.72 per share on $58 billion in sales. A modest increase probably translates to a gain of 2% or 3%, which would mean Caterpillar’s sales forecast is $1 to $2 billion below what the Street wants for 2019.

The back story: Caterpillar stock trades for 10.4 times 2019 earnings. That’s a big discount to the market. And its shares are down more than 20% from their 52-week high, leaving them in bear-market territory.

Investors often buy and sell in response to the rate of change for economically sensitive companies. Slowing sales growth is a signal that things can’t get much better, meaning it’s time to sell. Stock valuations, such as price/earnings ratios, drop and investors wait for growth to bottom out before buying shares anew. That’s what appears to be going on with Caterpillar, even though earnings haven’t peaked and revenue is growing.

The key question for Caterpillar and its investors is whether an economic slowdown will inevitably lead to a recession?

The plot twist: Swedish competitor
Atlas Copco
(ATCOA. Sweden) also reported earnings Monday. Its share have risen 5%. Order intake at Atlas rose 1% globally. A 1% increase isn’t great, so why the strong reaction? It’s not linked to Atlas’s valuation before the move: Atlas shares trade for 19 times this year’s estimated earnings, and Atlas stock has also performed better than Caterpillar shares over the last year.

There is a hint of inconsistency in the way Caterpillar and Atlas shares are trading. The divergent reactions show that investors are having trouble parsing the current macroeconomic environment.

Baird analyst Mig Dobre maintained his Outperform rating on Caterpillar shares, saying he doesn’t think the guidance was that all bad.

“Restructuring expenses are no longer excluded as they are returning to a normalized level, which has yet to be quantified,” he wrote. That means management’s forecast of $12.25 in EPS isn’t comparable to what Wall Street has been modeling. His price target is $167 per share, about 33% higher than the price Monday morning.

Other implications: Caterpillar is a bellwether industrial stock and its report will affect all the shares in the Industrial Select Sector SPDR ETF (XLI). Caterpillar Financial earnings also fell year over year. Past-due loans were up to 3.6%, versus 2.8% in 2018. Power markets remains weak. That’s not new news, but it isn’t good for other power-equipment players like
Siemens
(SIE. Germany) and
General Electric
(GE). Both companies report earnings later this week.

What’s next: Investors are still anxious about the economic cycle. Is growth finished or will Chinese stimulus and a dovish Federal Reserve improve the global outlook? We think a successful resolution to Sino-American trade tensions would go a long way to improving Caterpillar’s outlook. Chinese growth could accelerate and that would improve investors’ view of the stock.

Barron’s made Caterpillar a top pick for 2019 in December. Management updates investors at 11 a.m. on their quarterly conference call.

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